Wednesday, June 18, 2014

Big Ideas in Macroeconomics book review (full)

This is my full 5-part review of Big Ideas in Macroeconomics, by Karthik Athreya. Part 1: OverviewI finally got around to finishing Big Ideas in Macroeconomics, by Kartik Athreya. Certain people were not happy earlier this year when I wrote about the book before without actually reading it, so I read it quite thoroughly, and am now prepared to offer my thoughts in a multi-part review.

First, what is Big Ideas in Macroeconomics? It's an overview of modern macro. It has no equations and only a couple of graphs, but it's written in a dense, highly technical tone that will make it pretty opaque to any reader who is not either A) already familiar with most of the topics, or B) very smart.

Who should read this book? If you've taken graduate-level econ courses, Big Ideas will be a review, but it may point you toward a couple of important theory papers that you've overlooked; Athreya is verywell-read. So I'd say skim it for the lit-review value. If you haven't taken grad-level econ, but you want to understand modern macro, then my recommendation is to first read a textbook (e.g. this one), and then maybe skim Big Ideas for interesting paper references. If you're mostly just interested in the policy kind of stuff and informal ideas that you can read about in blogs - in other words, if you follow macro debates just for fun - skip Athreya's book; it'll be too dense, and you'll just get bored and quit.

If you're one of those few people who wants to understand macro by poring through dense literary tomes (Keynes, Hayek, Minsky), but who flees at the sight of a single equation, then I guess Big Ideas could be just the book for you. But to be frank, I don't think you'll really understand modern macro by reading this book. Maybe it's possible to write a book that teaches modern macro without equations - macro's answer to the Feynman Lectures? - but Athreya has not written it here.

Anyway, on to the substance of Big Ideas.

Deep within my cultural memory is buried a legend - the legend of the Scholastics. The legend goes like this: At the dawn of the modern age, when European rationalists and scientists began to unleash an explosion of creativity and free thought, there were a tribe of very smart, very learned people called the Scholastics, who devoted all their mental powers to defending the old Medieval understanding of the Universe. They produced exhaustive treatises defending old dogmas, and honed their logical thinking to a fine edge, but in the end they could not stand in the way of progress and were swept away. Deep within my cultural memory lies the boyish fantasy of confronting and defeating a Scholastic in an intellectual confrontation, in the name of a new scientific revolution. The 14-year-old in me still wants to be a fictionalized, Hollywood-ized version of Descartes, Galileo, or Francis Bacon, fighting for rationality, enlightenment, etc. etc.

(You can blame my parents for this. When I was 14, they packed me off to "philosophy camp".)

But anyway, this is the bias I have to overcome when thinking about Big Ideas in Macroeconomics. It definitely has the feel of a Scholastic apologia. The book is clearly intended as a response to the outside criticisms of academic macroeconomics that have proliferated since the 2008 crisis and recession. Some of the critics are bloggers like Paul Krugman or writers like John Quiggin, who criticize macro in the public sphere; others are economists like Dan Hamermesh, who had this to say in 2011:

The economics profession is not in disrepute. Macroeconomics is in disrepute. The micro stuff that people like myself and most of us do has contributed tremendously and continues to contribute. Our thoughts have had enormous influence. It just happens that macroeconomics, firstly, has been done terribly and, secondly, in terms of academic macroeconomics, these guys are absolutely useless, most of them. Ask your brother-in-law. I’m sure he thinks, as do 90% of us, that most of what the macro guys do in academia is just worthless rubbish. Worthless, useless, uninteresting rubbish, catering to a very few people in their own little cliques.

Ouch. Actually, I had never read that particular quote until I came across it in Big Ideas (Athreya is obviously very well-read). It's a much meaner version of what I tried to say in this editorial, and it's a meaner version of what you'll hear from a ton of non-macro economists in private discussions. The basic idea is that the macro field is not doing well, and pretty much everyone outside the field seems to know it.

A good number of people within the macro field agree, of course. But not all. Athreya is in the camp that thinks macro is basically doing fine. Big Ideas is his answer to the critics.

A lot of Athreya's rebuttal comes in the form of education. Athreya seems to believe that most of macro's critics just don't know enough about the field. He uses this Ariel Rubinstein quote to explain why he thinks outsiders shouldn't criticize macro:

"To criticize something, you need to know it intimately; the best way to know it intimately is to do it yourself. Once you have done that, you do not want to criticize it yourself."

Rubinstein, though tongue-in-cheek, does have a point - uninformed criticisms are likely to be poor. By Bayes' Rule, this means that Athreya is being rather charitable to the critics of macroeconomics when he assumes that poor critics are likely to be uneducated (rather than educated but politically motivated or just plain stupid).

But does this mean "outside" criticisms of macro should be discarded, just because they come from outside? Athreya does acknowledge, two pages later, that this process can lead to "capture" of critics - if the only legitimate critics of something are people who do it for a living, then the set of potential legitimate critics is pre-selected for people who will not want to be critics. (Athreya fails to mention a second, more cynical kind of "capture", which is that internal critics of a field are automatically "pissing where they sleep".)

This matters for society, because they're the ones who pay macroeconomists' salaries. Granted, it's not a large burden - if there are 3000 macroeconomics profs and govt. researchers in America and they earn an average of $150,000 each, then that's less than half a billion dollars total each year (the cost of two or three F-35s), for a field that has a shot at preventing trillions of dollars in lost output. But it's still something. Athreya's dismissal of outside criticism implies that only macroeconomists should be able to tell society how much it should spend on macroeconomists. At some point, society balks and stops forking over the cash - as it has with particle physics. Macroeconomics is much cheaper than particle physics, so we're probably not near that point, but it's something Athreya should think about.

Athreya also fails to deal with another reason for outside criticism - the need for "skin in the game" when it comes to policy advice. Macroeconomists are usually well-off people with good job skills, often with tenure, who won't really suffer if they give the government bad advice for dealing with recessions (though inflation would probably hurt them). There is also an externality, due to the fact that the marginal impact of a policy recommendation probably depends on how many other people are making the same recommendation. That means politicians need to be skeptical of academic macro (as, in fact, they usually are). If macroeconomists are just goofing around and having fun making unrealistic models and then giving policy advice based on those models, then outsiders are needed to point this out.

So I think Athreya shouldn't have been quite so dismissive of the idea of outside criticism. And though I like the idea of "rebuttal by education", I'm a bit pessimistic that it can really be accomplished.Part 2: Philosophy of ScienceIs Macroeconomics a science?

In the first section 1.2.1 of Big Ideas in Macroeconomics - yes, the sections are numbered like that - Kartik Athreya writes:

I will not go into the sterile - and crashingly boring - discussion of whether economics is a science or not, since relabeling it would change neither the questions we asked nor how we approached them.

This is a little odd, since he spends the entire section discussing exactly that question. His answer to the question of "Is econ a science?" is basically: "No, and that's fine."

For example, he writes:

My view is that a part of what we do is "organized storytelling, in which we use extremely systematic tools of data analysis and reasoning, sometimes along with more extra-economic means, to persuade others of the usefulness of our assumptions and, hence, of our conclusions...This is perhaps not how one might describe "hard sciences"...

[E]conomics is replete with "observational equivalence" whereby two (or more) sets of assumptions match a given set of data equally well. The paucity of data [with the power] to winnow the set of assumptions...is a huge problem.

One important difference between economics and physical sciences is that we economists have a hard time verifying the closeness of our standard assumptions to reality...Economists also lack axioms that closely approximate conditions in the real world the way that, for example, Newtonian axioms for projectile motion seem to. Seen this way, it is actually the collection of assumptions that we "like most" which constitutes our understanding of the world.

There is a second, even more substantial difference from the physical sciences: for most important macroeconomic questions, macroeconomists cannot conduct controlled experiments.

To recap, Athreya sees the following major differences between macroeconomics and "hard sciences":

1. Unlike hard scientists, macroeconomists must spend considerable effort persuading people of the likability of assumptions. The assumptions that macroeconomists "like most" are the ones around which consensus forms.

2. Because of uninformative data, macroeconomics can't offer the kind of robust, definitive answers to real-world questions that hard scientists can often provide.

That is basically my view of how things stand as well (though I'm more annoyed by the situation than Athreya is). By most people's definition, this would mean that macroeconomics isn't a "science". Athreya says that discussing that simple fact is "crashingly boring"...but one thing Athreya's book clearly demonstrates that he is not a man who is easily bored. More likely, Athreya realizes that our society has an unfortunate tendency to sneer and look down its nose at any academic discipline that is not labeled a "science". He realizes that relabeling macro a "non-science", while seemingly a pointless semantic question, will cause the field to lose prestige in the eye of the public.

I do think that the cultural importance of the "science" label is counterproductive. It's not the fault of historians, for example, that Francis Bacon's method offers only limited clues to history's mysteries.

But unlike Athreya, I'm deeply bothered by this "persuasion" thing. Athreya says macroeconomists' job is to persuade others of the "usefulness" of assumptions - basically, that macroeconomists are sort of halfway between scientists and lawyers. But persuasion, when employed on a mass scale, can turn the "wisdom of crowds" into the madness of herd behavior. People have an instinct for social conformity. And we tend to be overconfident in our beliefs, especially about complicated and difficult subjects.

Suppose - and I'm pulling this purely from my lower digestive tract here - that the data tell us that it's 63% likely that recessions are caused by financial market disruptions, and 37% likely that recessions are caused by productivity slowdowns. That's the best the data can do for us - there's no "falsification" here. The rational thing is for everyone to hold that 63/37 split in their minds as a Bayesian belief. But the rational thing is incredibly hard for real humans to do. Our brains urge us to turn our belief into a 100/0 thing - to decide that one assumption is right and the other is wrong. After we make up our mind, we try to persuade other people to do the same. Herd behavior and conformity work their magic. Political bias and other personal biases may come into play. Consensus forms. But the consensus has a big chance of being dead wrong.

Which is better - a firm consensus with a 37% chance of being wrong, or a distribution of beliefs with large confidence intervals, centered on the best possible guess? It depends, I guess. Sometimes, when you need quick action, and when human indecision is holding you back, the firm consensus might be better. But for the slow, ponderous task of figuring out how the world works, I'd prefer the latter. Consensus too often sends us down blind alleys.

I think a lot of people instinctively agree with me, and this is behind the calls for macroeconomists to be more "humble", or to "admit their ignorance", etc. It's probably one reason that macro doesn't often reach a general consensus. But I kind of worry that the amount of consensus that does get reached is too much.

But I feel like Athreya doesn't fully share my distrust of consensus. Section 1.3.1.5 of Big Ideas (yes, the book has subsubsubsections) is entitled "It Takes a Model to Beat a Model". This is a line I've heard before from a number of macroeconomists. The idea that models "beat" other models seems to indicate a preference for 100/0-type beliefs, at the individual level or at the group level.

Mathematics in Macroeconomics

Big Ideas has some other bits of philosophy that might interest people. Chapter 4 has a section (Subsubsection 4.2.4, to be precise) defending the use of mathematics in macroeconomics. The main reasons for math, Athreya says, are that it allows us to be quantitative (which we need in order to make policy), and it allows us to be precise about our meaning. That's pretty similar to what I wrote in this post a while back. And I still think these are good reasons to use math whenever possible.

Athreya makes an important point: Without math, discussions about theory often degenerate into arguments about "what Keynes really meant", or "what Hayek really meant", etc. Like prophets and philosophers, "literary" economists will inevitably get reinterpreted, misinterpreted, and conflictingly interpreted. Spend some time talking with those "heterodox" economists who believe that econ should be a purely literary field, and you'll see what I mean.

But Athreya goes further. He doesn't just defend the use of math in macro; he frowns heavily on any economic discussion that doesn't use math. From Subsubsubsection 4.2.4.2:

The unwillingness [of economists] to couch things in [mathematical] terms (usually for fear of "losing something more intangible") has, in the past, led to a great deal of essentially useless discussion.

The plaintive expressions of "fear of losing something intangible" are concessions to the forces of muddled thinking.

That's an interesting claim coming from a book that contains no equations...

But anyway, I think Athreya overlooks something important, which is the role of non-mathematical discussion in idea generation. Even when you use math to make a model, you don't start with the equations - you start by thinking about the concepts. Sometimes you need a lot of thinking before you come up with concepts that are interesting enough to model formally. Sometimes that thinking can't be done by just one person, and instead requires a discussion between people.

Sometimes, hidden among the reams of useless discussion, is a great idea that ends up turning into a great mathematical model. If you always start with the math, you can crank out models, but I think you might miss some of those deeper, bigger insights.Part 3: General EquilibriumOn the first day of my first-year microeconomics class in grad school, our professor took us down to the experimental econ lab and had us play a game where we all bid on various computerized "goods". Very quickly, a stable equilibrium price established itself. We didn't have much information - the prof didn't tell us who was bidding against whom, whether we had been given asymmetric information, etc. But again and again, prices converged to a stable equilibrium.This experiment was meant to show us that "general equilibrium" - which we spent the rest of the semester learning - is not just a fantasy that some economists dreamed up. The Big Idea in Big Ideas in Macroeconomics is Arrow-Debreu-McKenzie Equilibrium, which is basically the same thing as "general equilibrium" or "Walrasian equilibrium". Athreya tells us that this is the central concept in macro. Chapter 2 of Big Ideas is all about the Arrow-Debreu-McKenzie equilibrium concept. It's my favorite chapter in the book. Unfortunately it rambles, switching back and forth between explaining concepts (like the Welfare Theorems) and countering criticisms (like the idea that the Sonnenschein-Mantel-Debreu theorem makes general equilibrium useless). But it's still a good chapter, with lots of useful info and some very cool classic paper references. For example, I learned about this very interesting 1974 paper by Mount and Reiter, which shows that the prices in general equilibrium are, in a certain sense, very efficient at conveying information.Is Macroeconomics emergent?The coolest part of the chapter, in my opinion, is Subsubsubsection 2.6.3.1, entitled "Markets as Calculators". Contained within this obscure subsubsubsection is a discussion of a very deep question - whether "macroeconomics" really exists!

Ed Prescott famously disdains the term "macroeconomics", preferring the term "aggregate economics". The implication is that "macroeconomics" is just a straightforward summing-up of the behavior of a bunch of individuals. Modern macroeconomic models are made this way. Unfortunately, when we look at the real economic behavior of real individuals, it looks nothing like what you see in most of those macro models. This generally leads a lot of microeconomists to complain that macroeconomists are doing it all wrong - in fact, few micro theorists even work with Walrasian equilibrium anymore.

But what if Walrasian equilibrium is an emergent phenomenon? What if the aggregation of a whole bunch of behaviors that looks nothing like the simple stuff in a macro model ends up producing outcomes that look very much like the outcomes in the models? If so, then macroeconomics really is distinct from the rest of economics, and Walrasian/Arrow-Debreu-McKenzie equilibrium really is the right tool for macro.

Athreya discusses four results that suggest this possibility. First, there's the Mount and Reiter result about information and prices. Second, in Section 2.6.2.5, he discusses the literature on "market games", in which strategic interactions with only a little bit of centralized coordination lead to Walrasian equilibrium outcomes. Third, in Section 2.6.3.1, he discusses the large experimental literature, in which many types of market setups (such as the one I did in my grad school class) lead to Walrasian-type outcomes. And in that same section he discusses work that shows that even computers with very simple trading rules tend to converge to Walrasian equilibria in many cases.

This is very interesting stuff. It's also one of the only points at which Athreya shows a glimmer of doubt about the modern macroeconomic research program. He writes:

The fact that market participants lacking a [Walrasian clearinghouse] are able to trade as if there were one is thus amazing, and, interestingly, not such good news for modern [macro]economics...[T]heoretically based support (or doubt) of the likely outcome of a given set of rules is not necessarily a great source for good explanations of why outcomes look "competitive"...So if Walrasian equilibrium works well to predict outcomes in the lab, we may have the right answer but for the wrong reasons.

In other words, maybe Prescott is wrong, and an emergent "macroeconomics" does exist that can't easily be predicted by modeling people as "purposeful decision makers", as Athreya insists we do throughout most of Big Ideas. If that's the case, then departures from the Walrasian equilibrium base case can't be modeled by imagining how individuals would behave in response to the missing markets.

Is game theory a viable alternative?

The general equilibrium setup is pretty flexible, but it doesn't allow for strategic interactions - agents have to be price-takers. Thus, game theory is the main fly in the soup for proponents of Arrow-Debreu-McKenzie as the foundation of all modern macro. Athreya addresses game theory, but generally dismisses the importance of strategic interaction in the macroeconomy.

He does this in several ways. First, he discusses some common ideas about strategic interaction by firms monopoly - collusion, etc. - and claims that these are unlikely to be very important in the macroeconomy. Next, he cites the above-mentioned literature on certain games whose outcomes converge to Walrasian equilibrium. Then he asserts that the price-taking assumption - the key feature of general equilibrium - is a good assumption. Finally, he simply asserts that the macroeconomy is just too big for strategic considerations to matter:

Nearly any specification of interactions between individually negligible market participants leads almost inevitably to Walrasian outcomes...The reader will likely find the non-technical review provided in Mas-Colell (1984) very useful. The author refers to the need for large numbers as the negligibility hypothesis[.]

Well, that settles it!

But seriously, though some of what Athreya says is convincing, I do think there is at least one important strand of literature that Athreya misses - the literature on global games. Global games are a situation in which large - even infinite - numbers of agents, all acting independently, can move together like a herd. Here's a book chapter by Stephen Morris and Hyun Song Shin that explains how global games can have big macroeconomic outcomes. One example is currency crises, which contributed to deep recessions in a number of Asian countries in 1997.

Also, a number of modern macro models are introducing strategic interactions in the form of wage bargaining. This is important for models of unemployment and job search. So I think Athreya is a little too quick to totally dismiss game theory as an important tool for macro, though overall he does a decent job of dealing with it.

Answering the critics

Big Ideas is mainly a book about answering the critics of modern macro, and to Athreya, that means answering the critics of general equilibrium. This is the subject of a bit of Chapter 2 and all of Chapter 4.

In Chapter 2, Athreya talks about two theorems that people have used to criticize the use of Walrasian equilibrium - the Sonnenschein-Mantel-Debreu theorem, which shows that the economy doesn't have to behave like a single individual and that equilibria will in general not be unique, and the Boldrin-Montrucchio theorem, which shows that equilibrium prices and quantities can be chaotic. Athreya acknowledges these problems but basically waves them away, saying that we can safely assume that the non-uniqueness and the chaos will be quantitatively small.

We know that in the real world, macroeconomic quantities don't look too chaotic, so maybe that one can be waved away. But I'm not sure the problem of multiple equilibria can be so easily dismissed. Lots of perfectly standard models start exhibiting multiple equilibria once you let a little nonlinearity creep in. Macroeconomists' general approach is to assume away or ignore multiple equilibria. This practice has always annoyed me - if your model tells you a result, aren't you supposed to faithfully convey that result? Isn't that the whole point of this "assumptions lead logically to conclusions" game? Instead, when confronted with multiple equilibria, macroeconomists tend to just assume there's something wrong with the model, and go back to the drawing board, or else restrict parameter values just to make the indeterminacy go away. In Chapter 5 Athreya has a section entitled "Can Macroeconomists Put Enough Structure on Their Models to Avoid Generating Multiple Equilibria?"

But to me this just doesn't make sense; why should you torture your assumptions to make multiple equilibria go away, when they very well might be real? In Chapter 1, Athreya said that macroeconomists choose the assumptions that are the "most useful". If getting rid of multiple equilibria is a goal, then doesn't "useful" just mean "useful for getting the model to produce the desired results"? What's the point of reverse-engineering one's desired result? How is that a useful exercise? How does that help us understand the world around us?

...pant, pant.

Anyway.

Chapter 4 of Big Ideas is entirely devoted to answering critics. Athreya defends all the standard macro tools - representative agents, rational expectations, steady-state analysis, and expected utility. These debates are too deep for me to really get into - actually, they go way deeper than Athreya goes, too. If you want to know whether expected utility or representative agents are OK, you need to read more than is in this book. Athreya goes out of his way to defend these shortcuts - in keeping with the "apologia" feel of the book - and he does an OK job of it, given the space allotted.

Is general equilibrium "not even wrong"?

Arrow-Debreu-McKenzie equilibrium is a framework, not a theory or model. You can't falsify or disprove ADM as a concept, just like you can't falsify the practice of writing down reaction equations in chemistry. What you can do, theoretically, is show that the ADM framework is not the best framework in some certain situation. For example, if you find out that people are behaving strategically, in a way that affects the aggregate outcome of a market, then you know that the price-taker assumption is not appropriate in that case, and ADM is therefore not the best framework to use when modeling the situation.

Athreya, however, goes further, Section 2.9. He writes:

The basic ADM model is so general that it has no direct implications for what one should observe in the data...We simply see that a model that allows nearly unlimited richness and variation among its constituent parts also implies few sharp observable implications.

Actually, I think this is not quite right. ADM assumes the Law of One Price, and you can theoretically observe how well that holds. It also assumes that people behave as price-takers - if you can observe human intentions, and you see people behaving strategically (in a way that affects the aggregate outcome of a market), then you can see that ADM is not a good description of individual behavior (even if some ADM-like results may "emerge" anyway).

But it is true that the ADM framework is very very general. Fortunately, Athreya recognizes that being "not even wrong" is not necessarily a strength:

The unobservability of many aspects of the ADM construction is not all good, of course. Most obviously, it causes us real problems in assessing the relevance of the ADM framework in describing what we see around us...In fact, with no further restrictions...we ought not to expect any more definitive implications from the ADM model, such as outcomes (equilibria) that match even qualitative features of the data...[T]o generate predictions from actual observable data, we need to add more structure[.]

Arrow-Debreu-McKenzie/Walrasian/general equilibrium is the "Big Idea", but Athreya - correctly - recognizes that it's not enough. To be useful, macro needs some benchmark models that are far more restrictive and specific. General equilibrium is a "paradigm" in the sense of a framework for thought, but not a "paradigm" in the sense of a successful theory that you can tweak slightly in order to solve new problems.Part 4: Macroeconomics and the Crisis

Why did Kartik Athreya decide that now is the time to write a book defending macroeconomics from its many public critics? Probably because there are many public critics. And why are there so many? Probably because of the 2008 financial crisis and subsequent deep, prolonged recession. So it makes sense that a large part of Athreya's apologia would be about "Macroeconomic Theory and Recent Events" - as Chapter 6 of Big Ideas in Macroeconomics is titled.

But let's back up a bit, to Chapter 2, where Athreya writes:

[T]he overall conclusion one gets from the vast literature on industrial organization is that, with two exceptions, pervasive and important degrees of monopoly or oligopoly power do not play a dominant role in most modern economies most of the time...

The latter [exception] arises from the ability of financial "intermediaries" such as banks, insurance companies, and hedge funds, among others, to become considered "too big to fail" (TBTF). In this case, a very poisonous dynamic arises...Preventing TBTF and the corrosive effects on behavior that it generates are big pieces of unfinished business[.]

Hmm. Monopoly power isn't important in modern economies, except for TBTF? Where did the idea for that exception come from? I'm guessing it didn't come from a formal mathematical model with highly persuasive assumptions, written down by an academic macroeconomist before 2008 and published in a reputable journal. I'm guessing, instead, that it came from Athreya reading news and blogs.

When Kartik Athreya sticks "poisonous" and "corrosive" exceptions into his grand sweeping statements about the smooth workings of markets, you know something must have spooked him.

That something is the financial crisis of 2008. You'd have to be criminally insane not to be spooked by it. The wider world instinctively saw that the macro theories that they had been served up prior to 2008 - which said either that business cycles weren't bad at all, or that the Fed could handle them - were sorely lacking. The force of that realization, more than anything, is behind the proliferation of public macro critiques.

(Except for Yours Truly, of course. Yours Truly is merely venting his anger over having to get up at 7:00 in the morning and trudge through the snow to take Chris House's macro class back in 2007. 7:00 IN THE MORNING, DAMMIT. But I digress.)

In Chapter 6 of Big Ideas, Kartik Athreya explains and defends macroeconomists' response to the Crisis. He describes how, with amazing speed, macroeconomists started building models of how institutional problems in the finance industry could cause a crash. This really is The Hot Thing in macro these days, along with labor search models (Athreya also goes over both of these in Chapter 5). The sheer speed with which these models have been developed is a testament to the skill and intelligence of macroeconomists, the responsiveness of the macro community to real-world events, and the flexibility of the general equilibrium framework.

Athreya doesn't address the question of why these models weren't The Hot Thing in 2007.

Chapter 6 takes a detour into financial econ, including asset pricing, corporate finance, and banking. Athreya discusses heterogeneous beliefs and the limits of Rational Expectations, and whether it might be possible to detect and curb the growth of asset bubbles. He talks a little bit about debt vs. equity financing, and about banks and bank runs. This is all very good stuff, although these topics could (and do) fill many books each.

After that, Chapter 6 sort of disintegrates into a bunch of random stuff - unconnected, brief glosses over topics that Athreya probably couldn't figure out where to put. Actually, much of Big Ideas is arranged a bit haphazardly (much like this book review, actually, since I should have pointed this out in Part 1).

If you're searching Big Ideas for clues to Athreya's political outlook, it's in the jumbled Chapter 6 that you might find them. He takes one section to explain that modern macroeconomics is not inherently laissez-faire (and he's right), but he spends a lot of time cautioning against government intervention in the economy. Maybe that's because he himself is a laissez-faire sort of guy, or maybe it's because he thinks the critics of macro are mostly on the political left. In any case, that's about the extent of the book's political content.

The end of Chapter 6 - which is also the end of the book - is very revealing. Section 6.7.2 is titled "Where Did We Fail?", and Section 6.8 is titled "What Should Macroeconomists Be Doing?" These plaintive questions - which Athreya answers only tentatively - show that macroeconomists feel a bit under siege as a result of the crisis. Overall, Big Ideas can be viewed as a bunch of defensive rhetorical cannon, firing in all directions from the walls of the besieged fortress. Some of the cannonballs hit their mark; others don't. But Big Ideas shows that the castle is still being vigorously defended; the garrison is not yet ready to abandon the fortress.

But in those final sections, Athreya strikes a more hesitant tone. He writes:

Do macroeconomists have models that would produce a forecast for the likelihood of a huge downturn if they could clearly observe the full structure of IOUs across financial intermediaries and households? No. Could our models speak to the possibility that more relaxed underwriting standards would coincide with a period of extremely high price appreciation in real estate? No. Did our benchmark models suggest that, in the absence of any change in fundamentals, real estate prices could drop nationwide by 20% or more? No...

Macroeconomics, therefore, has a good deal of unfinished business, and so has failed, in recent years, to be useful in a variety of ways.

I suspect that the median macroeconomist can accept what I have just said. Nonetheless, I suspect that they think, for reasons I have laid out all along, that these reasons do not make a wholesale revamping of macroeconomics a good idea. A more measured response is the one that is already happening: the crisis and the slow recovery have yielded a sensible shift in priorities toward understanding the role ofhousehold finance (e.g., mortgage and student loans) and financial contracting between firms (e.g., repos) as sources of macroeconomic fluctuations.

This, I think, is the main message of Big Ideas: Outside critics, be quiet and let macroeconomists handle our own problems. We've got things under control. Our basic paradigm is sound; we'll fix things by evolution, not revolution, and we don't need you guys beating down our door with poorly informed criticism in the meantime.

Part 5: A Better Defense of Macro

Why write a book defending macroeconomics from the critics? Why go to such herculean lengths to extol something that has so far produced few usable results? It could be simple wagon-circling in the face of an external threat, but I doubt it. The American macroeconomist is an animal with no natural predators. Macroeconomics, as Chris House says, is "the glamor division of econ". Steve Williamson says: "We [macroeconomists] are among the best paid in the profession, we have more than our fair share of Nobels, and there is plenty of work for [us]". He's right. Macroeconomists serve the essential function of teaching America's future white-collar managerial class (undergrad econ majors) how to think about the Fed, the business cycle, etc. They have technical skills that give them lots of outside options for employment. Most of their theories can't easily be refuted by facts (look how long RBC has survived!), so they don't fear the wolf of empirical falsification the way, say, a biologist does. And other economists may grumble or taunt in private, but they have no intention of downsizing their macro areas. "Heterodox" critics, and ranty bloggers with highly idiosyncratic motivations (such as myself), are more like annoying birds that fly over and poop on the macroeconomists' habitat; we present no threat to their jobs or their prestige (since their prestige is determined entirely within the community).

So what's the point of writing a long, rambling apologia for modern macro? Maybe my original postwas right, and macro methods hold a strange, compelling attraction for the people who use them. Maybe that's all the reason one needs.

But if the purpose is to persuade and educate the public (rather than just to vent irritation or give praise), I don't think Athreya's book is going to do the trick. It's too dense for non-economists, and the organization is too scattered to really get any point across.

And although I'm sure this was unintentional, it comes off as a bit arrogant - the parts admitting macro's shortcomings are buried and scattered, while dismissals of "useless discussion" and "muddled thinking" among non-economists are sure to offend. Athreya's attempts to educate the mathematically illiterate about macro models, interspersed with condemnations of those who try to understand econ without math, probably just compound the problem. Statements about macro's failures and limitations would help, if they weren't buried so deep and scattered so randomly throughout the book. This is not intentional on Athreya's part; he doesn't mean to come off as condescending, but he almost certainly does so by accident. (Update: No, this is not sarcasm. I really do not think Athreya is an arrogant guy. Even if you don't take my word for it, the parts of the book where he admits the mistakes and limits of modern macro should serve as proof. Academics often talk in a way that comes off as condescending to non-academics; about 80% of the academics I know fall into this trap when communicating with the public. But relatively few are actually arrogant people; they are just used to giving lectures and arguing at seminars.)

So I don't expect Big Ideas in Macroeconomics to silence many of the critics, or to educate many people about the field.

Which is a shame, because I think this book could have made a more convincing case in defense of modern macro. It didn't make a bad case, but it didn't make a particularly good one either, and I think there's a better one to be made.

The better case is this: Modern academic macro, for all its flaws, is almost certainly better than any of the alternatives.

In Part 1, I mentioned the possibility that academic macroeconomists don't have much "skin in the game", and might just be playing around making fun spiffy models (and collecting fat paychecks) while the nation's job market goes down the toilet. Well, that's true, but is the problem any worse for the private-sector macroeconomists at Goldman Sachs? No, it's worse, because those people work for firms that have active macro bets! Private-sector macroeconomists have even worse incentive problems than academics, which is probably why politicians don't go to them for advice.

As for "heterodox" economists, the bald fact is that many of them are just political hacks (cue explosion in comment section). Take "Austrian economists", most of whom mix right-wing politics and econ theorizing like...well, similes fail me. But boy do they mix em. "Post-Keynesians" are somewhat less wedded to the political left, but still much more political than the mainstream folks. And MMT people...well, they're just waiting for their Lord Xenu to return to Earth and cleanse the unbelievers, or something.

Now, mainstream macro people have their political biases too. But they aren't as pronounced - they're subtle, hidden under layers of truly Byzantine obfuscation and compensation. Mainstream macro folks are probably a little to the right of other economists, and their deep-buried political biases probably seep out a little bit into their choices of modeling assumptions (for some more than for others). But there is great diversity of political opinion in the mainstream, and generally they try to keep a lid on it. Not so for the folks at the Mises Institute.

So who is left? What other tribe will tell the Fed how to set interest rates, or Congress when to spend money? Mainstream macro has its discontents, but the more time you spend among the people pushing the alternatives, the more you realize how much lesser of an evil the mainstream academics represent. In fact, since I started venturing into the world of the EconoTrolls back in 2012, I've felt a lot more guilty about dissing mainstream macro, and toned it down substantially. I mean, compare the most unfavorable possible reading of Big Ideas in Macroeconomics to some crap like this...there's just absolutely no comparison.

The fact is, mainstream macro is what we're stuck with. If it's going to be reformed, it's going to be reformed from within (possibly along with some pressure from non-macro economists). If macroeconomists are confident enough in their methods to avoid making more than a few tweaks to their methodology in the wake of a huge financial crisis and prolonged recession, then so be it. Big Ideas - even if they aren't Good Ideas - are notoriously hard to dislodge.

55 comments:

Thanks for doing this. It doesn't sound like it was a lot of fun. You've confirmed what David Glasner said: basically Athreya's macro is just micro, which I suppose is what Steven Williamson reckons it ought to be. As Solow remarked about that approach: these models don't have microfoundations, they are their microfoundations.

Hmmm. Well, it looks like Athreya sort of admits that maybe some work needs to be done about financial parts of the models, something about household finance, but all should bow down for insitutional and sociological reasons, even though we have heard a lot of grumbling coming from some of the most important customers of modern macro, namely the people making decisions in the front rooms at the Fed and even at the regional Feds.

So, is Athreya trying to address people like Kotcherlakota who were in the inner sanctum while in the backroom and have gone somewhat badly off the farm since going into the front room of policy making? It seems, Noah, that in the end your sympathy with Athreya sounds like people defending Thatcher (uh oh, does that make me sound too "political"?), There Is No Alternative (TINA). Is that it? All the hets are just too pathetic or whatever, even if occasionally their outside brick throwing breaks a window or two?

In the meantime, it looks like a lot of the decisionmakers are doing it by the seats of their pants, or maybe the pleats of their dresses, juggling between VAR-based models (did Athreya address those), remnant ISLM-Klein-Goldberger dinosaur models that Krugman more or less defends, and some DSGE stuff, with maybe an occasional look at some networky ABM kinds of stuff, along with their own internal herd effects. Is this then the bottom line, particularly if the DSGE people in the back rooms can continue to keep the ABMers and some of their less politicized relatives (maybe behavioralists, which Yellen may be covertly, given whom she is married to) at bay, as appears to be going on?

I just got finished reading a new post on Jason Smith's blog, where he makes the point that we can model a gas at the macro level w/o having to model the dynamics of every atom (here too). It sounds plausible to me that this ought to be analogous to macroeconomics.

Well, Noah, I personally favor Minsky-influenced ABMs with behavioral aspects, but as it has been a couple of years since I have personally worked with or written any papers based on such models, all I can do for now is stand outside cheering them on, along with throwing the occasional brick at the arrogant DSGEers. That they are not doing much better than they are, even with encouragement from some in the policymaking front rooms, is a matter of personal frustration for me.

Barkley

PS: To Tom Brown, yes, they have a lot of appeal and many cheering for them, but for now their suppression has been nearly complete, and it remains the case that not a single ABM paper has been published in a top-4 econ journal. The DSGEers point to this as proof that ABM no good, and as long as that persists, it will be hard for any ABMers to make it at leading schools, while some of us think that what is going on is an active effort to suppress ABM papers by DSGEers dominating the editorial apparatus at those journals, although saying this too publicly , as I am doing now, tends to just draw scorn from such folks, with accusations of silly conspiracy theorizing.

Complex systems analysis, as practiced by the entire field of meterology, has slowly but surely made very real progress. The dramatic advance was revealed when the correct (and not intuitive) path of Superstorm Sandy was predicted along with the strength of the storm, preventing a large amount of human suffering.

That's all of meterology working together under a shared and productive paradigm. The ABM people in econ are out there, doing good work (http://www2.econ.iastate.edu/tesfatsi/ace.htm), but progress will be slow as long as so much of the academy continues to insist that the emperor has fantasitic clothes, ie, equilibrium analysis has something useful to say.

Tom, Two points, which Noah can comment on, particularly if he disagrees (or anybody else). One, and this is not nice, it has long been my observation that DSGEers are not interested in testing their models in terms of forecasting. They calibrate them to reproduce the past, but they are not generally interested in forecasting horse races, although this is probably more due to the poor performance against VAR type models, which are used heavily for forecasting, but are pretty much devoid of theory.

The most standard riposte against ABMs is to fall back on theory, which is where Athreya's arguments become important (I do not know if he says anything about ABMs, although if he does not, that indicates another approach, which is simply to ignore this competitor). So, the lack of "microfoundations" in the form of either explicitly modeled rational agents or general equilibrium is held against them as simply a killer. They are therefore accused of being "ad hoc," and that is generally viewed as the kiss of death, particularly at top journals, although somehow the VAR models do not get rejected as much on such grounds, and Sims got a Nobel for more or less inventing them, although that is a long story...

Yup, DSGE has no forecasting power (see various papers by Gurkaynak). The excuse is that DSGEs are about policy, not about forecasting, but if the stuff outside of the model interacts with the policy, then lack of forecasting ability means the models are useless for policy too, and nobody admits or talks about this.

JBR, I thought you might be interested in the fact that "zero intelligence traders" produce a Walrasian type outcome in simulations. Those are technically ABMs; in fact, they're a damn simple form of ABM! That result could be used to gain some traction for ABMs.

ABMers should use that kind of stuff to sell their work, I think. It could really raise their credibility in the eyes of some mainstream guys (though not the RBC type faction that Athreya is allied with).

BTW, thanks for linking to your old econ trolls post. What a hoot. Realized that I have been falling into your stereotype about Post Keynesians in recent comments here, how embarrassing. Oh well, somebody has to keep those stereotypes up, I guess :-).

Probably because of the 2008 financial crisis and subsequent deep, prolonged recession.

This is just pathetic. The likes of Cassel, Fisher and Hawtrey had explained way back in the 1920s what would happen if nominal spending (NGDP or whatever you like to call it) fell - namely, a recession.

The fact that the profession still doesn't understand what happened in 2008 (or, for that matter, in the 1930s) leads me conclude that economists don't actually believe their own theories.

When push comes to shove, they go with their gut feeling (the banks dunnit) rather than with their models (sticky wages).

Macroeconomics doesn't need defending. It's just fine. It's the people who are the problem. The people who definitely should know better and yet don't.

Someone who says stuff like "printing money is deflationary" should be laughed out of the profession. And yet he's advising PhD programs.

Like Scott Sumner says - we could test macro theories, and yet we don't

http://www.themoneyillusion.com/?p=18185

Why is that ? Maybe (most likely) it's like Robin Hanson says

http://www.overcomingbias.com/2014/06/how-deep-the-rabbit-hole.html

The rabbit hole is indeed very deep. Economists don't really care about the usefulness of their theories and just want to signal tribal allegiances.

So the success of the mainstream macro is that it is better than a YouTube video??? Wow.

It may not even be true though. At least the video tied the economic activity to the demand for credit while for example Market Monetarists ignore credit and think the amount of base money dictates the economic activity across the economy!

As for the macro being useful in telling the government how and when to spend, read the completely confused Fama and Cochrane 2009. At least Cochrane redeemed himself in 2014, apparently read MMT and is making complete sense now. http://media.hoover.org/sites/default/files/documents/2014CochraneMonetaryPolicywithInterestonReserves.pdfLook also at inanities Krugman wrote in the 2000s about "exploding rates" due to high deficits, while if he had any clue about this stuff back then he would know that deficits bring rates down, not up.

I suspect deficits can bring rates up or down, depending on a variety of factors. Greece or Argentina vs. the USA, for example.

I still don't get what is so hard with Macro post-2008. We have a Great Recession b/c most ppl don't have money to spend and those who do certainly aren't interested in spending. What so fucking difficult to understand?

Not really, Daniel. You can read my views on MMonetarism and inflation: http://theredbanker.blogspot.com/2013/08/noahpinions-latest-on-loving-inflation.html and http://theredbanker.blogspot.com/2013/06/on-scott-sumner-monetary-policy.html.

My main issue with QEinfinity and inflation is that they do not give money directly to the people who would spend it. They rely on transmission channels that look very unreliable to me.

If MMers said, print $4tr and distribute it to the 99%, I'd be on-board.

given that some of the oldest ideas in macro concern the coordinated actions of large amounts of people (paradox of thrift etc.) it sounds like his attitude towards strategic interaction is rather glib!

Hold on. Just because someone's action doesn't have a direct impact on your payoffs, but only an indirect one through prices, does not rule out coordination failures what so ever. The paradox of thrift emerges in almost every new Keynesian model, in which all agents would be better off if they could gather in a city hall and agree to "stop this saving [not spending] nonsense". However, once they all agreed each individual have strong incentives to deviate (Euler equation doesn't hold anymore), and they all break their promises.

It's sad to see how people pretend these type of coordination failures don't exist in macroeconomic models when they are in fact littered with them.

Pontus is correct, and sadly, this was somehow missed in the lengthy review. Also, the book actually does talk about this in Chapter 5 (p.228-231). The section is called "One reason to think you can do better: Coordination Failure." Morris and Shin is indeed referenced, and the powerful potential role for policy to coordinate is talked about in the context of US civil rights legislation (and then in the context of "paradox of thrift") --surely as important a context as any related to business-cycle related. See also the the three detailed footnotes from that section.

Thanks for the review. I've been wanting to read this, but just reading this review was getting my hetrodox self all worked up, I will probably skip the book in order to keep my blood pressure at a safe level.

It is funny how you follow a section saying that economics is not a science with one defending the use of precise mathematics in econ. What do you think your being precise about, how many utils can fit on the head of a pin?

I am starting to be a (tentative, cautious) true believer in the importance and significance of complexity and emergence. Co-authoring a book chapter on complexity in the context of natural resource management made clear to me that complexity really bites at the macro scale, particularly to do with finance. If you (and JBR?) would be interested in seeing same, I could send you the draft when finalised..?

I'm still an undergraduate but doesn't Siglitz's work on the economics of information (summed up in Whither, Socialism) sort of put a stake into Arrow-Debreau? My understanding is that the assumptions required to get to a unique equilibrium are so heroic as to be laughable.

I don't think you need to use mathematics to be precise. Biology and medicine use words to be precise. Words are perfectly good at referring to things precisely. More precision is not a good reason to use mathematics. The reason to use mathematics is to make measurable predictions based on quantitative relationships. We have quantitative relationships from using maths, we just don't have any good measurable predictions.

Sure, sometimes it's possible to be precise without math. Actually, in the old days when economists actually believed in their math, they'd write some wordy intro sections that were very precise, then go on to the math. Some still do that. But a lot just let the math do the talking, and don't seem to really believe that the math is anything more than a very precise language.

So, Noah, I shall pick on a slightly more serious point, triggered by my own summary of your review. This is your use of the word "evil" in characterizing alternative heterodox models compared to mainstream modern macro ones. I am reasonably certain that you were intending irony here, or some sort of humor, although perhaps you were expressing annoyance with combative types like good old Steve Keen or the arrogant inconsistencies of Peter Schiff. But for an old guy with a beard whose wizarding skills are fading after too many trips to the South Farthing (or wherever), what is left of my memory is jangled by the use of such language in a discussion of economic ideas, particularly ones that may have political import as you suggested. Do you really want to imply that using such models might lead to death camps, serfdom, and mass starvation?

A couple of decades ago on a now defunct internet list I got into a debate with someone with apparently respectable academic credentials, editor of a mainstream mid-tier industrial organization journal (I know, how boring) who started accusing the late John Kenneth Galbraith of being a "Marxist, communist." I disputed this, which led this worthy gentleman to start making such accusations against me. He went beyond simply doing so on the internet list, but actually wrote a letter to my dean complaining about my obvious Marxist and communist tendencies shown by my willingness to publicly defend Ken Galbraith against such accusations. This would not be the last time that I was glad that I had tenure.

As it is, I suspect that your in-the-end defense of orthodoxy may reflect an accumulated effect of campaigning on the part of your eloquently orthodox major prof, Chris House, whom you quote, along with Steve Williamson's relentless assaults, even though it seems that about half of what he says is indefensibly absurd.

The entire concept of "equilibrium" is the reason that economics is in such trouble; to an economist a growing economy and a shrinking economy can both be described as being in "equilibrium." How many economists predicted the financial crisis, using their tidy and neat equilibrium DSGE models? To this day, both New Keynesians (which can be classified as pseudo-monetarists due to their love of ISLM and the implicit rational expectations/efficient market hypothesis assumptions behind most of their policy recommendations) and Monetarists (macrobullshitters) argue with each other over "policy prescriptions" despite the fact that the economy has not improved and the next financial crash or recession just might be around the corner. I believe that in order to truly reform economics you have to start reading and discussing heterodox economists, whose economic predictions are vastly superior to anything that neoclassical economists have to offer.

Remember a few years ago when Paul Krugman got into an argument with Steve Keen over the nature of banking? His conclusion was that banks are simple intermediaries that lend from patient lenders to impatient borrowers, which largely ignores the role of debt in the economy. Steve Keen and more recently, the Bank of England have completely falsified this bullshit model of banks requiring deposits in order to make loans. This is just one example where Heterodox economic thinking has outperformed mainstream Keynesian garbage (and I say garbage because Paul Krugman is not a true Keynesian, he's a Samuelsonian).

Please study Heterodox economists, they have arrived at their conclusions years before the charlatan Keynesians have. True reform starts with introducing new ideas from other schools of thought.

Math creates precise models. It also observably creates a mental bias against examining the assumptions and limitations of those models.Multiple equilbria is a great example - the math even throws it out for inspection - but economists don't like to think about it (largely because they aren't good at really hard math, so it scares them) and so we keep living through economic episodes where we bump along at some sub-optimal equilibrium that the econ theories tell us doesn't exist...

I'm really not sure it's acceptable to pretend this is not a problem - or that the GFC2008 was the first situation. In particular as soon as you get away from the USA we've had all sorts of deregulation experiments that provide good evidence for multiple equilibria and economies settling into not the equilibrium that the macroeconomic model predicts... Now we're living through it in the Western economies, yet still we can't seem to face up to the math...

On the to equate or not to equate debate, I say do both, explain in text and write the equation. The equation is can be very useful to clarify what exactly you mean in your "literary" explanation of your hypotheses. What non-economists mainly object to is that too many econ papers are unnecessarily unreadable to them because the authors don't bother to explain what after all are usually fairly simple models that could be explained with minimal text. That is, equations turn into a sort of economists' cant, which isolates them from society, which I think is unnecessary and unhealthy. Economists are writing ordinary everyday phenomena that ordinary people care about, so why not write in common language to the extent possible. Just as old-fashioned "literary" economists might have been forced to clarify what they meant if they wrote more equations, newfangled economists might be forced to better think through and confront the implications of their proposals if they had to write them in prose.

My problem with economics as a science:In "hard" science fields scientists have a default state (steady state, normal operating conditions, standard conditions... however they call it). If the situation falls outside of those conditions, they have to prove that steady state models work before they use them. Normal standard is that transients behave differently than steady state, until proven differently. (I'm talking here about models as approximations that work under certain conditions; there are always some basic models that explain (nearly) everything, but they cannot be used to calculate anything useful in reasonable amount of time without simplifications). Any (or almost any) model, theorem,... used in maths, physics and similar "hard" sciences either has area of utilization explicitly included in the model, or is so well known that everybody knows where it can be used (that is, has been proven to be adequate). But in macroeconomic, experts use models, like microfoundations, that reasonably explain steady state (near-full employment), to try and model clear transients (crisis in general, and once-in-a-lifetime crisis in particular) without even thinking that they may need to prove that those models work well for transients. And there are very, very few people in economics who find it strange.